Abstract
In this paper, we investigate the optimal hedging strategy in a continuous time framework that is more adequate for commodities. We consider the consumption-investment problem where all asset prices follow mean-reverting jump-diffusion processes. The optimal investment and consumption strategies are derived in closed form. The framework is used to address one of the major risk factors faced by commodity producers. We show that a commodity producer will be better off hedging his/her futures contracts by simultaneously investing in foreign exchange products to minimize the adverse impacts of the jump risk prevalent in commodity prices.
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